Do I need a promissory note when I lend money to my own business?

Yes. Owner-to-business loans without documentation are a common IRS audit target. The IRS wants to see evidence that a loan is a real debt (with a written note, interest, and repayment terms) rather than a contribution to capital. If the IRS reclassifies your "loan" as a capital contribution, you lose the interest deduction for the business and cannot claim a bad-debt deduction if the business fails to repay. A promissory note with proper terms is the primary documentation that the transaction was a genuine loan.

What interest rate should the note carry for a business loan?

For loans between related parties (you and your business, or you and a business partner), the note must charge at least the IRS Applicable Federal Rate (AFR) for the term to avoid imputed-interest treatment. For a short-term loan (3 years or less), use the short-term AFR. For mid-term loans (3 to 9 years), use the mid-term AFR. For longer loans, the long-term AFR applies. Find current rates at irs.gov. The rate must also stay under your state's usury cap, though business loans in many states have a higher cap or no cap at all.

How does a loan to an S-corporation affect the owner's basis?

For S-corporations, shareholder loans create "debt basis" separate from equity basis. This matters because losses passed through to a shareholder can only be deducted to the extent of the shareholder's combined stock and debt basis. A properly documented shareholder loan (with a formal promissory note, arm's-length interest rate, and real repayment) establishes debt basis that can absorb additional losses. Loans that are not documented or have non-arm's-length terms may be recharacterized as equity contributions, eliminating the debt basis.

Should the business be the borrower or should the note be between the owner and the business?

The borrower is the business entity (the corporation, LLC, or partnership). The lender is the individual owner or another entity. The note should identify both parties with their full legal names: "ABC LLC, a [state] limited liability company" as the borrower, and your full name and address as the lender. The authorized signer for the business (typically the owner, manager, or authorized officer) signs on behalf of the entity, not in their personal capacity.

When do I need a full loan agreement in addition to a promissory note?

A promissory note alone is sufficient for most simple owner-to-business loans. A full loan agreement (a more comprehensive contract) adds value when: the loan is large and you want ongoing covenants (the business must maintain certain financial ratios, provide regular financial statements, not take on additional debt without your consent); the business has multiple creditors and you want the loan to have defined priority; the deal involves a third-party lender alongside the owner; or the loan is to an entity you do not fully control (a minority stake). For a closely held business where the owner has complete control, a well-drafted promissory note is typically enough.

What collateral should I take on a business loan?

For a loan to your own business, collateral is less critical because you already control the assets, but it still matters in bankruptcy and for priority against other creditors. Common business collateral: accounts receivable (cash coming in from customers), inventory, equipment, and other business property. A UCC-1 financing statement filed with the Secretary of State perfects your security interest in these assets. For real estate owned by the business, a mortgage or deed of trust must be recorded. A "blanket lien" (covering all business assets) is the most comprehensive protection.

Can the business deduct the interest it pays me?

Yes, as long as the loan is structured as a genuine debt at arm's-length terms. The interest the business pays is a deductible business expense. You, as the lender, must report the interest received as income. If the rate is at or above the AFR and the note has real repayment terms, the IRS is unlikely to challenge the deduction. If the rate is below the AFR or the "loan" has no real repayment expectation, the IRS may disallow the business's interest deduction.

Promissory Note for a Business Loan

Lending money to a business, even your own, without proper documentation creates tax problems, basis problems, and collection problems if things go wrong. A properly drafted promissory note is the foundation of any owner-to-business or related-party loan.

Why documentation matters more for business loans

When you lend money to a family member, the IRS mainly cares whether you charged the AFR. When you lend money to a business you own, the stakes are higher. The IRS scrutinizes owner-to-business loans because they are a common vehicle for disguising capital contributions as loans, which incorrectly allows interest deductions and bad-debt deductions.

Courts and the IRS look at several factors to determine whether an owner's "loan" is a real debt or a capital contribution:

Is there a written promissory note?
Is there a fixed maturity date and repayment schedule?
Is an interest rate charged at or above the AFR?
Is interest actually being paid (not just accruing indefinitely)?
Does the business have other debt at arm's length (third-party bank loans)?
Is the business solvent enough that a real lender would have made this loan?

Checking the boxes on these factors, starting with a written promissory note, gives the transaction the documentation it needs to survive scrutiny.

Owner-to-business loans: the basics

An owner lending to their own business (a corporation, LLC, or partnership) is one of the most common forms of business financing. It is faster than a bank loan, does not require a credit check, and keeps the money within the owner's control. The owner becomes a creditor of the business.

From a legal standpoint, the business is the borrower and the owner is the lender. Even though the owner may also be the sole member or shareholder, the loan is between two legally distinct parties: the individual and the entity. Treat it that way. Use the business's full legal name on the note, and have the note signed by the authorized representative of the business (which may also be you, wearing your "manager" or "president" hat rather than your "personal lender" hat).

S-corporation basis: why the note matters for taxes

For S-corporation owners, the loan has a specific additional significance: it creates "debt basis." S-corporation losses passed through to a shareholder can only be deducted up to the sum of the shareholder's stock basis plus debt basis. If you have used up your stock basis with prior losses, a shareholder loan (evidenced by a promissory note) creates additional debt basis that allows you to deduct further losses.

The IRS has successfully disallowed S-corporation loss deductions in cases where shareholders claimed debt basis from loans that were not properly documented. A formal promissory note with real repayment terms is the primary evidence that the debt is genuine and the debt basis is valid.

When the business repays the loan, the repayments restore your debt basis in reverse. Talk to your CPA about the basis tracking if you have pass-through losses; the accounting can be complex, but the documentation starts with the note.

What to include in a business promissory note

Parties. Full legal names: your name and address as lender; the business's full legal name (e.g., "Acme Roofing LLC, a Texas limited liability company") and registered address as borrower.
Principal amount. The exact dollar amount being lent.
Interest rate. At or above the IRS AFR for the term. Use our Usury Limit Checker to confirm it is also under your state's cap (most states have higher or no cap for business loans, but verify).
Repayment schedule. Monthly, quarterly, or a balloon at maturity. A real schedule is important for the "genuine debt" analysis.
Maturity date. When the full balance is due. An open-ended loan with no maturity date looks more like equity.
Default and acceleration. Defines what constitutes default and the lender's right to demand the full balance.
Collateral (optional). Business assets, accounts receivable, equipment. Secured by a UCC-1 filing.
Authorized signature. The business's authorized representative signs on behalf of the entity.

When to add a loan agreement on top of the note

For most simple owner-to-business loans, a promissory note is sufficient. A full loan agreement makes sense when:

The loan is large relative to the business's assets, and you want ongoing financial reporting covenants (quarterly profit-and-loss statements, minimum cash balance requirements).
There are multiple lenders (you and an outside investor), and you need to define priority between them.
You want to restrict the business from taking on additional debt or selling certain assets without your consent.
The business has other creditors and you want to clearly establish the priority and terms of your loan versus theirs.

A loan agreement is a broader contract that incorporates the note plus these additional obligations. The note "evidences" the debt; the loan agreement governs the relationship.

Collateral: protecting yourself as a creditor

If the business fails and there are multiple creditors, secured creditors recover first. If your loan is unsecured, you stand in line with all other unsecured creditors and may recover little or nothing.

Filing a UCC-1 financing statement names you as a secured party over specific business assets. A blanket lien (covering all present and future assets of the business) gives you the broadest protection. File with the Secretary of State in the state where the business is located.

Secured Promissory Note Check State Usury Limit